Metropolitan liberals love to be able to criticise Western society. Recently, their lives have been brightened by the extensive discussion on the rise in inequality since the 1970s, especially in the Anglo-Saxon economies. There is a danger that this essentially anti-capitalist narrative will come to dominate the media, paving the way for increased regulation and the sorts of failed statist interventions in the economy which were a consistent theme in British political economy for nearly four decades after the Second World War.

On a global scale, in terms of the degree of inequality which exists between nations, the past 50 years have seen a huge movement towards a much more equal world. And it is precisely the institutional structure of capitalism, of companies motivated, at least in part, by profit, operating in a market-oriented system, which has brought this about. A system which England introduced to the world in the late 18th century with the Industrial Revolution.

Until then, over the whole span of the millennia of organised human society, in terms of difference in living standards between regions, the world had been a very egalitarian place. Most people lived for most of the time on the brink of starvation. A summary measure of inequality which is widely used is the so-called Gini coefficient. In a completely equal society, the Gini coefficient is zero – no inequality – and in a society in which one person has all the income it is 100. So the higher the value, the more unequal the society. For most of human history, the Gini coefficient between regions of the world seems to have been between 10 and 15, a far more equal distribution than currently exists within any individual country.

The dramatic subsequent success of capitalism in certain parts of the world led to a marked widening of the degree of world inequality. Growth did not stand still in, say, Latin America, but it was much faster in Western Europe, North America and Australasia. By the middle of the twentieth century, the world Gini coefficient was just under 50, its peak level. The club of prosperous nations which had formed by 1870 was essentially the same in 1950.

Japan forced its way in, with absolutely spectacular growth in the 1950s and 1960s, closely followed by other East Asian countries such as South Korea and Taiwan. More recently of course, China and, to some extent, India, have adopted capitalist principles of economic organisation and have boomed as a result. In the former Soviet bloc, those countries which oriented themselves to the West and have prospered and others, like Russia itself, have floundered. Even in Africa, which went backwards following independence in the 1960s, there are very encouraging signs of recent progress.

In terms of differences in per capita income levels between countries, the world is now much more equal than it was in 1950, and probably at around the same level that it was in 1850. And it is capitalism which has brought this about.

Imagine that, for some reason, you were forced to choose between having to read a long, turgid novel like Westward Ho or Middlemarch, or a book on the methodology of the national economic accounts. Most people, however reluctantly, would plump for the former. But the latter can at times be very exciting. A recent paper uses national accounts concepts to revolutionise the conventional view of world trade.

Robert C Johnson of the National Bureau of Economic Research has a long article in the latest issue of the top ranking Journal of Economic Perspectives, entitled ‘Five Facts about Value Added Exports’. He uses the fundamental national accounting distinction between gross value and value added. International trade data record the gross value of goods and services as they cross borders. The value added measure subtracts from the gross value of, say, American exports, all the imports into the United States which have been used to produce the exports. Like it says on the tin, the value added measure tells us how much value has been added to the American economy by the exports from that country to the rest of the world.

The measurement of GDP is based on the principle of value added. A company may, for example, produce a car for £10,000. But the value added by that company is not the gross figure of £10,000. It is what is left when the value of all the materials and other inputs bought by that company have been subtracted from the sale price of the car.

Until recent decades, it was reasonable to assume that there was a not a vast difference between the gross value of exports and their value added. But the rapid rise of global supply chains has altered this dramatically.
Johnson’s most spectacular finding has important implications for the UK and the debate about our place in the world. On the conventional measure, manufacturing accounts for some 70 per cent of gross exports across the world, and services for 20 per cent (the rest is basically agriculture and mining). Using the value added measure, manufacturing and service exports are very similar in size, at around 40 per cent of the global total of exports. There are two reasons for this. Manufacturing firms buy substantial amounts from domestic service sector companies, and manufacturing exports in general contain a higher import content. The UK, of course, is very strong in service exports, but apparently less dominant than we believe.

The value added approach can also lead to different conclusions in terms of evaluating exchange rate movements. Strikingly, Johnson finds that the real value of the Chinese currency in these terms is 20 per cent higher than suggested by the conventional approach, so the Chinese exchange rate is not all that misaligned. But intra-EU rates are more misaligned, especially for the peripheral countries which are currently in trouble. So the problems of the Euro zone are worse than is perceived.

Yes, national accounting conventions can certainly be more gripping even than The Killing!

In the year to March 2014, consumer prices in Sweden fell by 0.4 per cent. This has prompted the central bank, the Riksbank, to abandon the normally cautious language used by such institutions. Over the same period, inflation was negative in a further seven European countries, such as Greece, Portugal and Spain. In eight other countries, inflation was still positive but very low, running at an annual rate of less than 0.5 per cent.

The Riksbank argues that these very low, often negative, rates of inflation are caused by a ‘very dramatic tightening’ of monetary policy. There is a definite risk of a slide into a prolonged depression similar to that of the 1930s.

Surely low inflation is a good thing? Well, up to a point, Lord Copper. The current batch of policy makers, scarred by the double digit inflation rates of their formative years in the 1970s and early 1980s, have been obsessed with controlling inflation for at least the past twenty years. They seem to have succeeded. The highest rate of inflation in Europe is currently that of the UK, at a mere 1.6 per cent a year. Thirty years ago, it was well in excess of 20 per cent a year.

The problem with low inflation is that debts, both public and private, retain their real value. A classic way in the past to cure a large debt overhang was to allow inflation to erode its value. Immediately after the Second World War, for example, the British government appeared virtually bankrupt. Public sector debt was 250 per cent of GDP, compared to its current level of around 80 per cent, a figure which still gives cause for concern. But the debt was fixed in nominal terms. Anyone who bought a government bond for £100 and held it to maturity would get £100 back. Inflation ensured that £100 was not worth what it used to be.

Under the long period of Conservative rule from 1951-64, inflation was low, with an annual average of 3.3 per cent. Even this was sufficient for prices to rise nearly 60 per cent. £100 in 1951 was only worth £64 in 1964. Inflation plus strong real economic growth, which expanded GDP considerably, wiped out the problem of public debt.

The real question is whether policy makers can do anything to increase inflation. The fact is that they did not collectively, across the developed world, suddenly become geniuses over the past two decades and learn the secret of inflation control. Inflation fell everywhere, despite, until the crash at least, steadily falling unemployment. The single most important reason for this was the integration of India and China into the world economy, and the huge increase in competitive pressure which this brought. This has not gone away.

We seem to be stuck with very low inflation for a considerable period. Instead of trying to put prices up, policy makers should encourage growth. Not by irresponsible increases in public spending, but by tax cuts and encouraging the entrepreneurial culture.

The performance of the BRIC economies over the past decade or so has been mixed. Russian growth, though impressive by Western standards, has lagged that of both India and China. This is particularly true since 2008. I got an insight into the problem at a conference last week at the Economics Institute at St Petersburg University. Incredibly, it has a total of 64,000 students. Cynics might say that a country which produces so many economists is bound to perform badly.

We went to the Rector’s office. On the staircase immediately outside was a massive bust of Nikolai Voznesensky, Chairman of the State Planning Commission in the Second World War, responsible for organising the entire Soviet economy. Voznesensky was described to me in glowing terms as ‘a great man’. But there, too, were photographs of all the previous Rectors, prominently displayed. There had been a very rapid turnover in both 1937 and 1938, with one man lasting only six weeks in the job. Why?

I looked up the Collected Works of Stalin. Anticipating Andy Warhol by decades, he wrote ‘Under socialism, everyone will have the right to be Rector of Leningrad University for 15 minutes’. Well, of course, this last bit has been made up. The years 1937/38 were the very height of the Soviet show trials and purges, and all the Rectors had been shot in rapid succession.

So, standing in front of these rather moving and haunting photographs of leading intellectuals, all victims of socialism, I was receiving a eulogy of the man who ran the Stalinist command economy. This seems to encapsulate Russia’s problems. What is the dominant narrative? Is it to break with the past, honour those whose lives were destroyed, and in so doing move forward? Or is to look back with nostalgia at the apparent security of the planned economy?

Talking to the students, there were much more optimistic signs. They were lively, enthusiastic, wanting to speak better English and do interesting work. We could almost have been anywhere. But even here, a theme ran through the narrative, the overall view of the world, which they had constructed about Russia’s future. None of this group wanted to restore socialism, the idea did not even cross their minds. Nor were they entirely sure of the blueprint to try and follow. But the financial crisis has clearly compromised the view that the Western model is the one which must be followed to generate successful economic development.

The recent crisis has simply not been on the same scale as the Great Depression of the 1930s, when output in the US fell by nearly 30 per cent. Mere facts, however, do not shake a settled narrative. The psychological impact of the crisis has been to give countries like China and Russia even more confidence that they can reject the free market, private property, liberal democracy model of development. Outside the developed economies, it is a seductive message.

In the whole of the 20th century, only a few countries managed to transform themselves and join the club of rich economies. Japan is the most prominent example. The key question for the first half of the 21st century is whether or not China will manage to do the same. It is a difficult and elusive feat, and the number of failures, of countries who nearly made it but then fell back, is as great as the successes.

It is only a few decades ago that there were serious doubts about Japan’s capacity. They were stereotyped as producing cheap, shoddy manufactured products, and at best managing to copy in an inferior way goods made in the West.

Last week, I was in Hangzhou, a Chinese city of millions of people which most people have never heard of. There was prolific evidence of poor copying in the many slogans translated into English which adorned massive development sites, billboards and shops. The graphic phrases were somehow not quite right. The undoubted winner was a clothes shop which proudly styled itself ‘Fashion Fuck All’.

I had been invited to speak at a conference celebrating the launch of the Alibaba Complex Systems Research Center. ‘Alibaba?’ I hear many people ask. It is an internet company which does both business to business and business to consumer transactions. When Facebook was floated, it was valued at $16 billion. There is terrific excitement and speculation about the public offering of Twitter at a possible $20 billion. Alibaba is in the final stages of negotiations over its own IPO. The current estimate is that this will be valued at $70 – seventy! – billion.

Japan rose to economic prominence by making complex and sophisticated products at least as well as, and often better than, the West. Now, the Western economies are dominated by the services sector. The key point about Alibaba is that it is not just in the services sector, but in the fastest growing, cutting-edge technology part of the whole sector. In a city which most people in the West could not place on a map, a company unknown to many is planning a public offering which will make it worth twice that of Facebook and Twitter combined. The company in terms of revenue is already easily the number one in e-commerce in the world, and the IPO will give it the appropriate capital value.

Retaining the top spot in any businesses based on the internet is far from easy. As recently as 2008, MySpace, a precursor of Facebook, was the world’s most visited website, and until 2009, America’s, pulling in 70 million unique US users a month. And then all of a sudden, it died. Alibaba may find challenges in replicating in America and Europe its stupendous success in East Asia if Western consumers take time to trust what is for them a relatively unknown offering. But even so, the company shows that China is able to leapfrog the process of development and compete effectively in the leading sectors of the world economy.

It has suddenly become fashionable to be concerned about China’s growth rate slowing down. This is not a matter of a short-run cyclical downturn, with normal service being resumed shortly as the economy roars ahead once more. It is a worry that there will be a permanent slowdown by the end of this decade. Instead of annual growth rates around 10 per cent and even more, the Chinese economy will settle down to the much more sedate rates seen in the West in the 1950s and 1960s in the range 3 to 5 per cent.

The source of the problem, it is argued, is that the workers are getting a bit uppity. Certainly, the Chinese authorities have held down increases in the living standards of the average person. The economy as a whole has grown faster, with the surplus being ploughed back into capital investment projects.

A couple of years ago I was in Shanghai in August. It was 35 degrees even at nine in the evening. Watching a group of middle aged women perform Pilates in the street to the sounds of an old ghetto blaster, I could not help but feel: it will not be very long before they demand an air-conditioned gym and cutting edge music. More seriously, ‘internal security’ is a major headache for the Communist Party. There are frequent demos and riots demanding more.

We have been here before. This is how the UK industrialised. In the first half of the 19th century, the share of wages in national income was much lower than it is now. As with China in recent decades, profits were high. This is how almost all rich countries started on the path of development. Marx even coined a phrase for it: the ‘primitive accumulation of capital’.

Paul Krugman was not always the darling of the metropolitan liberal elite. In 1994, he published a brilliant paper in which he wrote of his ‘faith in free markets’. The title was ‘The Myth of Asia’s Miracle’. Twenty years ago, the West feared economies like Japan and Singapore, which were apparently poised to take over the technological leadership of the world. Their growth rates had been spectacular.

Krugman essentially rediscovered Marx and showed that their success was effectively based on letting profits and investment boom. He concluded ‘If there is a secret to Asian growth, it is simply deferred gratification, the willingness to sacrifice current satisfaction for future gain’. Intriguingly, given the current advocacy of increasing government debt, Krugman went on: ‘That’s a hard answer to accept, especially for those American policy intellectuals who recoil from the dreary task of reducing deficits and raising the national savings rate’.

But the slowdown in Asian growth rates was not at all bad news. Rapidly rising living standards created export markets for consumer products. In China – and everywhere else – people now demand services, the sorts of things in which the US and the UK excel. The process of China growing up is a massive opportunity, not a problem.